Financial management is one of the most important responsibilities of business owners and managers. They must consider the potential consequences of their management decisions on the company’s profits, cash flows, and financial condition.
The activities of every aspect of the business have an impact on the financial performance of the company and must be evaluated and controlled by the business owner.
Finance is the blood of any business. However, finances, like most other resources, are always limited. On the other hand, desires are always unlimited.
Therefore, it is important for a business to manage its finances efficiently. As an introduction to financial management, in this article, we will look at the definition, functions and examples or types of financial management.
Table Of Contents
1 What is Financial Management?
1.1 Some Definitions According to Experts:
2 Functions of Financial Management
2.1 Knowing the Business Life Cycle
2.2 Financial Management in Normal Operation
2.3 Business Operations Reporting
2.4 Filing and Paying Taxes
3 Types and Examples of Financial Management in Business
3.1 1. Treasury and Capital Budget Management
3.2 2. Capital Structure Management
3.3 3. Working Capital Management
3.4 4. Financial Planning, Analysis and Control Management
3.5 5. Insurance and Risk Management:
What is Financial Management?
Let us know the meaning of financial management as the first part of an introduction to financial management.
For any business, the finances it earns must be invested in such a way that the return on investment is higher than the finance costs. In short, financial management is
- Efforts to reduce financial costs
- Ensuring the availability of sufficient funds
- Relates to planning, organizing, and controlling financial activities such as procurement and use of funds
Some Definitions According to Experts:
“Financial management is an activity related to the planning, collection, control, and management of funds used in business.” – Guthman and Dougal
“Financial management is the area of business management devoted to the prudent use of capital and the careful selection of capital sources to enable spending units to move toward achieving goals.” – JF Brandley
“Financial management is the operational activity of a business that is responsible for obtaining and effectively utilizing the necessary funds for efficient operations.” – Massie
Financial Management Function
Knowing the Business Life Cycle
Most companies experience losses and negative cash flows during their initial period. Financial management is very important at this phase.
Managers must ensure that they have enough cash to pay employees and suppliers even if they have more money going out than coming in during the initial time of the business.
This means the owner must make financial projections of this negative cash flow so that he or she has an idea of how much capital is needed to fund the business until it becomes profitable.
As a business grows and matures, it will need more cash to finance its growth.
Planning and budgeting for these financial needs is very important. Deciding whether to fund the expansion internally or borrow from an outside lender is a decision made by the financial manager.
Financial management is finding the right source of funds at the lowest cost, controlling the company’s cost of capital and not allowing the balance sheet to be overly impacted by debt with adverse effects on its credit rating.
Financial Management in Normal Operation
In its normal operation, a company provides a product or service, makes sales to its customers, collects money, and starts the process all over again. Financial management moves cash efficiently through this cycle.
This means managing the raw material and finished goods inventory turnover ratio, selling to customers and collecting receivables on time and starting over with buying more raw materials.
Meanwhile, the business has to pay its bills, its suppliers, and its employees. All of this has to be done with cash, and smart financial management is required to ensure that these funds flow efficiently.
Although economies have a history of long-term gains, they will also experience sharp declines at times.
Businesses must plan to have sufficient liquidity to deal with this economic downturn, otherwise they may need to close their doors due to a cash shortage.
Business Operations Reporting
Every business is responsible for providing reports on its operations. Shareholders want regular information about the returns and safety of their investments.
State or local governments need reports so they can collect sales tax. Business managers need another type of report, with key performance indicators, that measure the activities of different parts of their business.
In addition, a comprehensive financial management system is capable of producing the various types of reports required by all these different entities.
Filing and Paying Taxes
The government is always there to collect taxes. Financial management must plan to pay taxes on time.
Financial management is an essential skill of any small business owner or manager. Every decision made by the owner has a financial impact on the company, and he must make these decisions in the context of the total operations of the company.
Types and Examples of Financial Management in Business
One of the main types of financial management decisions is to establish and improve organizational valuation. Here we will look at the three main types of financial management decisions and an example of where they all work to achieve a common goal.
1. Treasury and Capital Budget Management
Capital budgeting is a planning procedure used to decide whether a company’s fixed assets, for example, new plant, new machinery; New research projects are feasible to allocate funds through the capitalization structure of the organization (equity, debt or profit margin).
Many formal strategies are used in capital budgeting, For example: Profitability index, Payback period, Net present value, Real options valuation, accounting rate of return, internal rate of return, Equivalent annual cost and many more.
This management team is also responsible for raising funds and investing funds. In the event that an organization merges with another organization or expands, the team will facilitate the financial need for the merger or expansion.
2. Capital Structure Management
In corporate finance, capital structure is the way in which a company finances through a mix of debt or equity securities.
Debt financing comes as a bond issue, whereas equity comes from retained earnings or as shares. Short-term debt financing, for example, working capital requirements are also seen as a major aspect of the capital structure.
Here the financial management team is responsible for the capital structure of the company’s short-term debt, long-term debt, equity, preferred stock and more.
When teams are referring to capital structure, they may consider a company’s debt-to-equity ratio, which provides an understanding of how financially healthy the organization is or how financially risky the organization is.
3. Working Capital Management
Working capital management of an organization refers to the management of bookkeeping methodologies and accounting strategies intended to track current assets, current liabilities, cash flow, inventory turnover ratio, working capital ratio and more.
The basic role of working capital management is to ensure the organization reliably holds sufficient liquid cash to meet its short-term debt and operating costs.
This is one type of financial management where the team needs to maintain working capital management for the smooth operating cycle of the company, and also to increase the company’s revenue.
4. Financial Planning, Analysis and Control Management
Financial planning is an attempt to decide how the business will achieve its main goals and targets.
More often organizations make Financial Plans after the vision and mission are set. The Financial Plan describes each activity and exercise required to achieve this goal.
Financial analysis is a way to analyze businesses, budgets, projects and other financial-related matters to decide on their implementation, suitability and performance. Regularly, financial checks are used to detail whether the company is stable, liquid, or productive enough to allow any investment.
Financial controls are actualized procedures, arrangements and methods for managing finances. The financial control framework provides management with an instrument to refine the achievement of operational goals and objectives.
These types of financial management decisions are made by teams that are more often than not responsible for the bookkeeping office, budget division, and audit-related work.
5. Insurance and Risk Management:
Insurance and risk largely share the same goal of minimizing organizational risk; however specific strategies are applied to achieve this goal.
The risk management team is responsible for minimizing organizational risk factors that are a threat to their business operations. For example flood, fire or other natural disasters.
This type of financial management is largely responsible for establishing techniques to enable the organization to remain profitable without being affected, by natural disasters or price changes due to currency differences.
At the same time, taking the best insurance plan with the right benefits and the right amount of coverage for an organization is also important, to limit the organization’s threat to risk or lawsuits.